A bite of Apple by 1TleT690


									My bite of the Apple
updated: 2/21/2011 (spring 2012)
                The Outline
1.   The theme-Great company, Cheap price.
2.   Business analysis
3.   Financial analysis
4.   Stock valuation
5.   The moat
6.   Risk
7.   Bulls vs. bears
8.   Investing strategies
                  The theme-business
• With the dropping of “Computer ” from its name, and the introduction of
  iPhone, the era of Apple is coming back, at a larger stage. Apple now is a
  4-cylinder engine: Mac, iPod, iPhone and iPad lines, and each is a power
  house. Each segment is a $10-20 billion business.<overview>
• As the only vertical integrated PC software and hardware maker, Apple
  had lost itself in the WinTel world for more than one decade. iPod saves
  and lifts this company, causing so called Halo effect and helped increase
  Apple’s market share in PC from less than 3% to 10% ( in US). However, it
  is iPhone that is the real game changer, for Apple as well as for cell phone
  and PC industry. iPad is yet another evidence of Apple’s strength in
  innovation and yet another indication that next big thing from Apple could
  be around the corner. <some details>
• Apple is the only $200+ billion company(market value) that still grows at
  50% rate. Apple’s unique tracking record of innovating into a new field and
  dominating that category defies the rule of “too big to grow fast” to some
  degree. <uniqueness>
                            The theme-stock
• As of 2/21/2012, the market stock price is around
  $500, and we believe its fair value is around $800.
• Considering its potential growth in next 5 years,
  continuous growth from innovation in the long term,
  and rich free cash it has accumulated and continue
  to generate, it is still very cheap with a 15- PE.
• AAPL has been a very volatile stock for the last three
  years and will continue to be. The combination of its
  risk and return offers great opportunity for patient
  investors who buy growth at value price.
• Recommendation: BUY
•   Disclaimer: this is an example of stock analysis for educational purposes. The professor is not
    endorsing any stock in this class.
 Business Analysis-Macro Economy
• The state of our economy (also see separate slides).
• The state of the overall stock market.(see stock
• The impact of slowing economy on AAPL
   – products
      • Products sold at premium price would suffer
      • Some purchases will be postponed, but not discarded
      • Innovative products at its early life cycle will still grow
   – Financial strength
      • A strong balance sheet with enough cash is an important
        competitive advantage
Business Analysis-Industry Analysis
• See separate slides for smart phone and PC
  industry analysis
  Business Analysis-The Products
• Overview: Segments, size, market share and
  – Mac (hardware and software): 14M units ,4% PC share; 30+% growth,
    3 times industry average. Down to single digits during recession.
    Rebounded to 32% growth in 2010.
  – iPod (also iTune, and accessories): 50M units, 70% US market, negative
    growth. Down 7% June09 Q , first decline since introduction. Will
    decline at 10% rate
  – iPhone: 10M + units 2008, 20M 2009, 40M 2010. huge growth
    potential, might reach 100M in 2013, and 150M 2015. The King of the
  – iPad: 10M first year of introduction, 20M 2011, 50M 2015
 Business Analysis-The Products-iPad
• Tablets Demand-why users want it?
     • When
        – Travel, at home or in class
     • What
        –   Web
        –   Email
        –   Video (youtube, Netflix, iTune, Hulu)
        –   Ereader, enhanced books, textbooks (interactive features)
        –   Create documents
        –   Other: games, music
     • More for individual than for business use(?).
        – Realtor, Spaceship
        – Conferences
  Business Analysis-The Products-
• Tablets Demand-more on e-textbook
  – The rising e-textbook tide
     • Publishers are embracing e-textbook at a very fast
       speed. In fact, many text books now have a e-version
     • E-textbook has very little marginal cost
     • E-textbooks are not resalable (unlike used books,
       publisher and authors always get paid)
     • E-textbooks offer interactive features for homework
       and exams, and many more.
  – A hardware is needed, cheap and capable. (iPad?)
  Business Analysis-The Products-
• Tablets Demand-Addressable Market
    • Tablet offers portability and size that is between PC and
      smart phone
    • Tablet is a complement of PC, not a replacement(?).
    • The addressable market is big in absolute size
      (150million users), but smaller than PC (1 billion user)
    • Annual sale will be around 50 million units in 5 years
    • Pending demand is high
  Business Analysis-The Products-
• Potential Supply (tablet industry)
  – PC makers (HP, Dell, Acer..)
  – Smart Phone makers (NOK, Samsung)
  – Ereader (Sony, AMZN)
  Business Analysis-The Products-
• Post iPad launch and the users
  – Users love their iPads
  – 3.2 Million sold in June Q
  – Production cannot meet demand
  Business Analysis-The Products-
• Post iPad launch and the tablet industry
  – The surprise
     • $500 is a bad surprise for competitors
     • iPad an extension of phone OS, not Mac OS
         – Always on, long battery, not Hot!
  – The Consequence
     • HP, Microsoft’s failed first strike
     • Delayed launch of other tablets
     • E-reader price war
  – Current competition (Lenovo, Dell, Android)
  – Future competition
   Business Analysis-The Products-iPad
• How WinPad can win?
  – Match features
     • Price
     • OS: Win 7 mobile OS, system always on, no starting
     • Battery
     • Form-weight, thickness
     • Apps
  – Differentiate
     • MS Office, Flash
     • Connections with other devices, print
     • Different forms (7”, 5”, 11”..)
  Business Analysis-The Products-
• iPad
  – Strength<?>
     •   Apps
     •   Price-$499
     •   Battery-10 hours
     •   iPhone OS: easy to start, always on, low consumption of power
     •   Fast, no virus, no pop ups, no frozen screen
  – Weakness<?>
     •   No openness (store files, play video and music from other sources)
     •   No Flash
     •   No real keyboard
     •   No MS office
  Business Analysis-The Products-
• iPad sales, profitability and stock value added
  – Commands 30-50% share of tablet market
  – 6 million units for fisical 2010 (twice the units of
    all kindles sold so far), 20 mil 2012.
  – Gross Margin: 35%
  – iPad standalone stock value: $45 B, or $48/share
     • Sales=$600*20M=$12b
     • Operating Profit: 12*35%=$4.2b Net Profit:
     • Assuming PE=15 3*15=$45b market capitalization
Business Analysis-The Products-iPhone
Quick survey
  – satisfaction
     • Smart phone ownership and satisfaction
     • iPhone ownership and satisfaction
     • Other smart phones satisfaction
  – Plan to buy
     • Buy iPhone
     • Buy other smart phones
  – Why like iPhone?
  – Why not?
Business Analysis-The Products-iPhone
 Strength
– Non-defendable
    – All-in-one pocket device
    – Full screen
    – Touch (vs. keyboard, tracking ball…), (Win vs. Dos), important
      for applications (calculator, etc..)
    – Ease of use
    – An evolving phone: your phone gets better without hardware
– Defendable
    – The brand (innovative, cool, high quality, premium brand)
    – Multi-touch:
        – Critical for small screen device, great for internet
        – Protected with patent, challenged by Palm Pre, and more challengers to come. Just sued HTC, and
          Google could be next
    – App store
    – iTune Ecosystem: (medium file manager and on-line store)
Business Analysis-The Products-iPhone
 Weakness
   – Real issue
       – A closed system
       – The exclusive carrier: smart decision or not?
       – The data fee: an opportunity for a no-data fee competitor?
    – Non-issue
       – The battery: not enough for a heavy duty day
       – The keyboard: Need hepatic feedback?
       – The device price
    – The features: what should be included and what should
    – Weakness from your user experience
Business Analysis-The Products-iPhone
• The iPhone-competition
   – Competition: Is the “Storm” coming? Is it time for “Dream”?
   – New Entry:
       •   Traditional phone makers
       •   Smart phone only makers
       •   New comers
       •   PC guys: Dell, HP, Lenovo, Acer
   – Create and continue dominance like iPod? Or fade away like Mac before
   – Possible outcomes of smart phone industry
       • Co-existence of several major brands, hardware and platforms
       • A dominant player (winner takes all)
       • A universal operating platform ( Google, WinMobile)
   – Projection of smart phone industry market share in 5 years
Business Analysis-The Products-iPhone
• The iPhone: sustainable competitive advantage
   – Strategic Strength
       • Strength
           – Software and applications: smart phones will be software centered
           – Hardware: a fashion statement
           – PC expertise: the phone feature is less important, and the computer features
             are the differentiator
           – The App store and iTune
           – The brand
           – The customer loyalty: the highest among competitors, always
           – The focus and economy of scale
Business Analysis-The Products-iPhone
• It is the software!
   – Old game (hardware) vs. Apple (Software)
   – I don’t see new form factor in the near future
• Using App Store to distinguish from competitors
   – Get iPhone/iTouch to mass market
   – Making development tools easy to use
   – More App, less in-house software
• Using iTune content to distinguish ..
Business Analysis-The Products-the Mac
        »Relatively free from most viruses
        »Fast speed
        »Most applications are free
        »Design driven (first all-in-one design)
     –First to see the desktop to laptop trend
     –Strong brand in US, especially college
      ( Hollywood?)
Business Analysis-The Products-the Mac
   • Weakness
       »Win compatibility, pose long term
       »Lack of applications
     –High price
     –Less brand recognition outside US,
      especially developing countries
     –Penetration in business not successful
Business Analysis-The Products-the iPod
   • Strength
      –   iTune, a ecosystem, a plat form, not just device
      –   First mover advantage
      –   Brand,Design
      –   Economy of scale(cost),Marketing
   • Weakness
      – Does not own content
      – Too strong brings too many enemies ( studios-NBC, digital
        distributors-Amazon, device maker-Microsoft, Dell)
      – Low bar of entrance (digital retailer is easy to start)
      – Converging to converged device ( the phone)
      – Market Saturation
         Financial Forecasting
– Top-down product driven approach
  • Sales
     –   Revenue driver
     –   Market share: (Too big to grow)
     –   Units
     –   Average Selling Price (declining ASP)
             Financial Forecasting
– Sales: I expect sales to double in three years ( from Sept 2011 to Sept 2014)
     • Units: sales will be driven by iPhone and iPad. iPhone from 70M+
       to 250M+, iPad from 30M to 80M+, Mac from 15M to 30M
     • Market share: iPhone 30%(smart phone share), iPad 40%, Mac
     • ASP:
         – ASP for consumer electronics and PC declines over time in
           general, due to lower component cost and competition
         – Apple is good at NOT competing on price by differentiation.
         – Still, Apple product price follows a downward trend
             Financial Forecasting
• Profits and margins: from top line to bottom line
   – Gross margin
      • Competition will force price cut and reduce margin
      • Component cost declines over time
      • Higher revenue and big orders of components give apple
        increasing bargaining power on component cost
      • the changing mix of high margin vs. low margin products
      • Labor cost might rise
   – Operating margin
      • Economy of scale. Fixed cost is fixed, average cost down, Net
        income increases faster than sales and expense/sales ratio down
        over time
   – Profit margin
      • Interest, Tax
          Financial Forecasting
  – EPS=Net Income/Number of shares outstanding
  – Number of shares: SEO, normal Dilution, option
                  Stock Valuation
•   FCF model
•   PE approach
•   Forward PE
•   Five year super growth P/E model
    – Simple and useful
    – Financial forecasting beyond five years is of little value
    – Five year super growth: growth will eventually slow down
      due to competition and rule of big numbers
    – Assuming industry average P/E in five years
               Stock Valution
• Free Cash Flow(FCF) model
  – Consider FCF as the theoretical dividend that can
    be paid
  – It works like a two stage dividend growth model
              Stock Valuation
• Sensitivity Analysis
  – Future=uncertainty
  – Output depends on inputs and model
  – Map possible inputs and output (price)
                       The moat
• Definition of moat:
   – Long term sustainable competitive advantage
   – Wide: The company still owns the market if it stands still
     for five years
   – Narrow: The company can stay ahead of its competition if
     it keeps moving faster than competitors
   – None: The company can be outpaced by competition any
• Components of moat: Switching cost, network effect,
  scale of economy, brand, intangible assets
• Google, Facebook, MSFT,NFLX,Railroad, Utility
  The moat: Apple-Narrow but growing
• The brand commands premium, and enjoys
  – Q: who is willing to pay premium for those brands
     • AAPL, Dell, SONY, Tiffany
• The innovation is not a one-time wonder
  – Apple II, Mac OS, iPod, iPhone, iTune, App store
    The moat: Apple-Narrow but
• Is there a switching cost?
  – In class survey: will you switch?
  – iOS: Users do not want to switch OS. There is a
    time cost of learning
  – Apps: they cost money, contain personal
    data(1password, notes, iBook) and won’t work on
    other OS.
  – Content: music/video purchased from iTunes with
 The moat: Apple-Narrow but growing
• Network effect: The value to individual users increases
  as more users use the product/service.
   – the more users of iOS, the more developers, the
     more Apps and the more users. It is a good cycle,
     like a rolling snow ball.
   – Facetime, Game center
   – The gravity of mobile OS will concentrate on iOS
     and Android. Together, they may take 50%-75% of
     smart phone and tablet market
                                  The risk
• Steve Jobs: The priced in expectation is that he will stay active as CEO for a
  least 5 more years(60 years old) and probably less than 10 years (65). If he
  stops working for health reasons, AAPL might lose $25b to $50b value
  instantly. Any speculation of his health will also cause the stock price
  fluctuate in a large range
• Competition: AAPL is not Microsoft at any fronts it competes.
    – Enemies:
         • Enemy number 1: Google. Competes with AAPL on mobile OS, Tablets, internet TV,
           and possibly music.
         • Enemy number 2: Microsoft
         • Smart phone family: NOK, MOT, HTC, Samsung, RIMM
    – Price and margin pressure
                          The risk
• Disruptive technology: like Cloud computing does to
  Microsoft, Smart phone does to Nokia.
• Double Recession: we should still see growth, but slowed
• Regulation: not a big concern as Soft or Intc, but a growing
• Quality issue, product failure
   – Antenna gate for iPhone4.
   – Explosive iPod in Japan
   – White iPhone delay
• Lawsuit: patent lawsuit banned it from delivering smart
                   Bulls vs. Bears
 The Bear
• Too big: AAPL has a market cap higher than Soft, and the only
  direction from top is going down.
• Valuation: Current valuation is still high, compared with Soft
  and Intc.
• Android: Competition like Android is catching up
• Margin: Margin might collapse because of competition
• Growth: Growth will slow down. Rule of big numbers.
• Double dip
                Bulls vs. Bears
• The Bull
  – iPhone and iPad revolution, just the beginning.
  – The halo effect
  – The moat
  – The vision and innovation into a different industry.
  – FCF conversion, Large cash reserve
  – Valuation still low
            Investing Strategy
• Ladder Approach
  – Buy at 20% discount
  – Overweight at 30% dis
  – Leap call option at 40% dis
  – Short term call options at 50% discount
   Notes-new developments since spring 2010
• iPad sales exceeded expectation by wide
• Antenagate
• 2010March and June Q exceeded expectations

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